The Bank of England Gets It…

The Bank of England has been behind the curve when it comes to recognizing the depth and severity of the global economic slowdown, and has kept interest rates too high for too long. But it has finally woken up to what’s going on, if today’s huge (and important) interest-rate cut of 1.5 per cent (slashing the benchmark rate by a third), is any indication. That still, to be honest, leaves interest rates in the U.K. too high, at three per cent, but that also means that the Bank can cut again soon if, as seems likely, that’s necessary.

What’s interesting is that the foreign-exchange market reacted to the interest-rate cut not by driving the price of the pound down, as would traditionally be expected (lower interest rates would typically make a currency less attractive, not more, as would the longer-term inflationary impact of lower rates), but by driving it up. This fits with the fact that the value of the dollar has actually gone up in the past month, even as the U.S. government has been cutting interest rates and printing money for programs like TARP. In effect, investors seem to be looking past the short-term negative effects of interest-rate cuts on currency values, and betting that those economies that are reacting most quickly and most dramatically to the crisis will remain stronger (and more attractive to investors) during the recession and will return to economic growth more quickly. This creates something of a virtuous cycle for a place like the U.S., because it means we can reap the benefits of lower interest rates in terms of growth without, at the moment, paying any price in terms of higher inflation due to a weak currency.

James Surowiecki is the author of “The Wisdom of Crowds” and writes about economics, business, and finance for the magazine.